Until 2024, a small Category I or II AIF with a corpus of ₹500 crore or less could hold its own investments without a custodian. That exemption has gone. SEBI now requires every AIF to appoint a SEBI-registered custodian, and new schemes must do so before their first investment. This article explains the current rule, what happened to the transition deadline for older schemes, the strict conditions for using an associate as custodian, and how custody connects with the demat requirements.
Every AIF must appoint a SEBI-registered custodian for safekeeping of its securities. Following the January 2024 amendments, new schemes must appoint the custodian before making their first investment, and existing schemes had to comply by 31 January 2025. An associate of the sponsor or manager can act as custodian only if strict conditions are met, including a sponsor or manager net worth of at least ₹20,000 crore.
What changed in the custodian requirement?
Before 2024, the SEBI (Alternative Investment Funds) Regulations, 2012 required a custodian only for Category III AIFs, for Category I and II AIFs with a corpus above ₹500 crore, and for Category I and II AIFs dealing in credit default swaps. Smaller Category I and II schemes could hold securities themselves.
Amendments notified on 5 January 2024, followed by a SEBI circular dated 12 January 2024, extended the requirement to all AIFs. Regulation 20(11) now requires the sponsor or manager of every AIF to appoint a SEBI-registered custodian for safekeeping of the AIF's securities, and the custodian also reports on the AIF's investments as SEBI specifies.
| Scheme | Before January 2024 | Current position |
|---|---|---|
| Category III | Custodian required | Custodian required |
| Category I and II, corpus above ₹500 crore | Custodian required | Custodian required |
| Category I and II, corpus ₹500 crore or less | Exempt (unless dealing in credit default swaps) | Custodian required |
By when must the custodian be appointed?
- New schemes: schemes that had not made any investment as on 12 January 2024, and all schemes launched since, must appoint a custodian before the date of their first investment.
- Existing schemes: schemes that had made at least one investment as on 12 January 2024 had to appoint a custodian on or before 31 January 2025.
The January 2025 transition deadline has passed. Any scheme that still does not have a custodian is now simply non-compliant, and the gap should be disclosed and corrected without delay. Annual compliance test reports and the PPM audit will both test this.
Can an associate of the sponsor or manager be the custodian?
Yes, but only under Regulation 20(11A), which sets strict conditions. An associate custodian is allowed only if all of the following are met:
- Net worth. The sponsor or manager of the AIF has a net worth of at least ₹20,000 crore at all times.
- Board independence. At least 50% of the custodian's directors do not represent the sponsor, manager or their associates.
- No subsidiary relationship. The custodian and the sponsor or manager are not subsidiaries of each other.
- No common directors. The custodian and the sponsor or manager have no common directors.
- Independence undertaking. The custodian and the manager give an undertaking to act independently of each other in their dealings with the AIF's schemes.
Existing associate custodian arrangements also had to meet these conditions by 31 January 2025. In practice, only large financial groups can meet the ₹20,000 crore net worth test, so most managers appoint an unrelated custodian.
How does custody connect with demat holding?
The same January 2024 package dealt with dematerialisation. SEBI requires that investments made by AIFs on or after 1 October 2024 be held in dematerialised form. Investments made before that date are generally exempt, except in specified cases. Units of AIFs are also issued in demat form under Regulation 10(aa), with the detailed timelines set out in the Master Circular.
Demat holding and custody work together. When securities sit in demat accounts operated through the custodian, the custodian can independently confirm what the AIF holds, and its reports to SEBI can be reconciled with the AIF's own reports. That is much harder when share certificates or physical records are held by the manager.
Some investee entities, such as LLPs or private companies that have not dematerialised their securities, can make demat holding difficult. Managers should check the demat position before investing, not after, and document any exception relied on.
What does the custodian do for an AIF?
For investors, this means the existence of the fund's assets is confirmed by an independent, regulated entity, not only by the manager's statements. Our article on the Category III leverage breach timeline shows the custodian's monitoring role in practice.
What should managers consider when choosing a custodian?
For many smaller Category I and II managers, appointing a custodian was a new exercise. Beyond SEBI registration, practical points to evaluate include:
- Coverage of unlisted assets. Venture and private equity portfolios hold unlisted shares, CCPS, CCDs and sometimes LLP interests. Confirm how the custodian handles each.
- Onboarding time. Account opening and documentation can take several weeks, which matters if a first investment is imminent.
- Reporting capability. The custodian's data should align with the AIF's reporting to SEBI, investors and the valuer.
- Cost structure. Fees are usually based on assets under custody and transactions; check how they are charged to the scheme and that this is permitted by the PPM.
- Exit terms. Understand how holdings would be transferred if the custodian is changed later.
Starting this process early in the fund launch timeline avoids delaying the first close or first investment.
Custodian checklist for AIF managers
- Appoint a SEBI-registered custodian for every scheme, and for new schemes before the first investment.
- If the custodian is an associate, document compliance with every condition in Regulation 20(11A) and monitor the ₹20,000 crore net worth test at all times.
- Disclose the custodian in the PPM and update the PPM if the custodian changes.
- Hold investments made on or after 1 October 2024 in demat form unless an exception applies, and record the basis for any exception.
- Reconcile custodian holding statements with the fund's books regularly.
- Include custodian compliance in the annual compliance test report and PPM audit.
Funds granted ‘Inoperative Fund’ status under SEBI's June 2026 winding-up framework are exempted from certain continuing requirements, including some custodian requirements. That exemption applies only after the status is granted and does not affect operating schemes.
Frequently asked questions
Is a custodian mandatory for all AIFs?
Yes. Since the January 2024 amendments, Regulation 20(11) requires the sponsor or manager of every AIF to appoint a SEBI-registered custodian, including Category I and II schemes with a corpus of ₹500 crore or less.
When must a new AIF scheme appoint a custodian?
Before the date of its first investment. Schemes that already had investments on 12 January 2024 had until 31 January 2025.
Can a group company be the custodian of an AIF?
Only if all the conditions in Regulation 20(11A) are met, including a sponsor or manager net worth of at least ₹20,000 crore, at least half of the custodian's directors not representing the sponsor, manager or their associates, no subsidiary relationship, no common directors and an independence undertaking.
Do AIF investments have to be in demat form?
Investments made by AIFs on or after 1 October 2024 must be held in dematerialised form, subject to limited exceptions. AIF units are also issued in demat form.
What does an AIF custodian report to SEBI?
The custodian reports on the AIF's investments periodically in the format SEBI specifies. For Category III AIFs, it also reports leverage breaches to SEBI.
Is the 31 January 2025 deadline still relevant?
Only as history. It was the deadline for existing schemes and associate custodians to comply. Any scheme without a custodian today is non-compliant and should correct the position immediately.
Conclusion
Custody is no longer a feature of only large or Category III funds. Every AIF scheme now needs a SEBI-registered custodian, appointed before the first investment, and associates can play that role only under strict independence conditions. Combined with demat holding, the rule gives investors and SEBI independent confirmation of what each fund owns, which is a basic expectation of institutional-grade fund governance.
Launching or managing an AIF?
H K Davra & Co. supports AIF managers with SEBI compliance, PPM audits, CA certifications and investor reporting.
Talk to usThis article is for general information only and does not constitute professional advice or solicitation. Provisions are summarised as of October 2026. Please refer to the relevant provisions and seek advice on your specific facts.